Your investments: Using stocks in place of bonds

According to ICI data, over $150 billion has flowed into bond funds so far this year. This continues trend of huge inflows since 2009.

US dollars 390.
(photo credit:Thinkstock/Imagebank)

As global financial markets continue their volatile way, many investors have
thrown in the towel regarding investing in stocks and have moved all their money
into bonds. As investors stay glued to every news report that may shed light on
the potential collapse of the Euro, as well as a slew of new data showing a
slowing US economy, preservation of capital has taken on added
importance.

According to ICI data, over $150 billion has flowed into bond
funds so far this year. This continues a trend of huge inflows since
2009.

History

Traditionally yields on bonds outpaced the dividend yield
on common stock.

This is a reason that investors would incorporate bonds
into their portfolio.

They could get a fixed yield and a reasonable level
of safety. In fact, according to data from the widely acclaimed Yale economist
Robert Shiller, since 1962, top quality bonds in the US have carried an average
yield of 8 percent, while stocks have yielded an average of 3%.

Not so in
2012.

Today if someone promises you a guaranteed 8% yield you can be sure
that there is something very fishy going on.

Due to this huge influx of
cash being used to buy bonds, bond prices have skyrocketed, meaning that yields
on traditional income-producing investments like investment-grade bonds and
deposits are paying next to nothing (inverse relationship between bond prices
and yields).

It has gotten to the point that in many cases, a company’s
stock dividend is much higher than the bond yield of the same issue. It’s this
search for yield that has created an interesting situation.

Investors can
now generate more income from stock than they can get in a bond of the same
company.

Higher income

According to Jack Hough of SmartMoney magazine,
“Investors who buy Procter & Gamble [PG] bonds that come due in 15 years get
a yield to maturity of about 3% a year. Those who buy the company’s stock,
meanwhile, get a dividend yield of 3.7%.”

Hough continues, “P&G
raised its dividend payment by 7% in April, marking 56 straight years of
increases. If a company increases its dividend by 7% a year, payments to its
shareholders will more than double by year 12, while those to its bondholders
will be unchanged. But over a long enough time period, dependable dividends can
offset much of that uncertainty.

If P&G can grow its dividend
payments by just 5% a year, then after 13 years, stockholders will have
collected more than $66 in dividends for each $61 share they bought
today.”

This means that not only do you generate the income, but you have
potential capital appreciation as well. Other well known companies like Chevron,
Coca Cola and Johnson and Johnson have similar metrics. It’s important to keep
in mind that as opposed to bonds, stocks can lose some of or all of their value
and companies can cut their dividends. Just because PG has increased its
dividend for 56 consecutive years, doesn’t mean that if their business begins to
suffer – that they won’t cut or eliminate their dividend altogether.

Not
for everyone

In this interest-rate environment, one should take a long look at
dividend paying stocks as a way to help lower market volatility and generate
income. It’s important to emphasize that fixed-income investors who try to
enhance the income generated in their portfolio solely through investing in
dividend-paying stocks are doing so at their own peril.

The chance that
the stock bought drops substantially surely exists. Stock market investing is
risky, and as such, someone living on tight fixed income should stick to low
yielding bonds instead of putting principal at risk. But for investors who have
some wiggle room regarding the income they need to generate in order to meet
their lifestyle, or are looking for an alternative to a highly-volatile
portfolio, dividend paying stocks in this current environment are worth
investigating.

aaron@lighthousecapital.co.il Aaron Katsman is a licensed
financial adviser in Israel and the United States who helps people with US
investment accounts.